Banks Could Have Worst Yet To Come, Warns Paul Tucker

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Paul Tucker, deputy governor of the Bank of England, has warned the worst could still be to come for the banking sector as he called for an end to the get-rich-quick culture of the City.

The lead candidate to take over from Sir Mervyn King as governor of the Bank

of England, Tucker told a City audience: "There is a tangible probability – not a high probability – that the worst may still be ahead" for banks, which was why they needed to hold more capital.

Calling for changes to the way bonuses are paid to bankers, he stressed there was not a "single policy initiative" to make the system safer after the 2008 taxpayer bailout and warned that policymakers would face a backlash when they took measures to prevent exuberance in the future.

Threadneedle Street wanted to make it easier for new banks to increase competition, he said: "I would say that the Bank believes what it always believed: that sound and honest finance is not only essential for the economy, it will be good for the City too."

He said the Financial Policy Committee, on which he sits, was concerned a "tidal wave" could be coming. "We may all be grateful that there is a few billion more of capital here and there in the banking industry, keeping banks in the private sector rather than the dead hand of state ownership."

Tucker outlined a number of reforms which were needed, and described the breakup of the Financial Services Authority into what is known as "twin peaks" – with the Bank getting banking supervision and the new Financial Conduct Authority looking after consumers – as "25 years too late".

Tucker said bankers needed to be paid in subordinated debt and put more focus on customer service rather than sales and on the medium-term success of the firm.

"Putting it bluntly that would make it less easy to get rich quick irrespective of the quality of the business transacted or the compliance culture in their part of the firm," Tucker said, indicating this would require changes to the codes on remuneration.

He said branch managers needed to no longer be seen as "an exercise in sales and marketing" but instead make credit judgments.

While changes are under way, Tucker said that all risk could not be avoided: "We need to find broadly the right balance between, on one hand, safety and, on the other hand, the contribution that sound and honest finance can make to economic prosperity.

"We may not be able to abolish the occasional waves of optimism that grip humanity and the tendency to excess when they set off. But we can and must dampen their effects on the financial system and economy. This must include changing the incentives that bankers face."

He was addressing a City audience at the annual British Bankers' Association at which the FSA's managing director, Andrew Bailey, said he had made it clear to banks that the need to hold more capital should not be used as a reason to restrict lending to households and businesses.

The FSA was allowing banks to eat into "capital planning buffers" of £100bn so Bailey said that it should see "a change in the course of credit creation by those banks without going far into those buffers".

He said the government's funding for lending scheme, intended to cut the cost of borrowing, "should improve credit creation in the economy through lowering rates on new lending – but to some degree it may also enable banks to improve their net interest margins and thus build more capital".

Bailey also praised banks for the forbearance they are offering on loans by restructuring the debts of customers in trouble: "I think banks deserve a thank you for the way in which they have sought to use forbearance. It is easy to imply that forgiveness is a bad thing, turning Japanese in the unfortunate sense of that term. Rather we should deal with the consequences of forgiveness not prevent it. The reason for that is because forgiveness has a very good side to it, namely that fewer jobs are lost and fewer homes repossessed where it takes place."

Tucker also said banks needed to hold more capital as this would reduce the returns that banks can provide to shareholders and make investors demand bigger dividends – " a bigger share of the cake " – potentially reducing bonuses.

Tucker added that holders of bank bonds needed to absorb losses when banks run into trouble, which they did not during the 2008 crisis and were effectively bailed out by the taxpayer. The Independent Commission on Banking's ringfencing proposals should help establish different cultures in investment and high street banks, Tucker said.

Powered by Guardian.co.ukThis article was written by Jill Treanor, for guardian.co.uk on Wednesday 17th October 2012 12.02 Europe/London

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